12
17-22
Chapter 17
Chapter 17
17-23
17
Employee Compensation—Payroll, Pensions, and Other Compensation
Issues
Overview
Employee compensation is an accounting issue that affects every
company. The issues that affect every company are relatively
straightforward and easy to apply. That being the case, they don’t
make up the bulk of this chapter. Instead, most of this chapter
deals with employer-provided pensions of the defined benefit
variety.
Due to the costs, and risks, to the employer, defined benefit
pensions are not common in newer or smaller companies. However,
they still exist for many large companies that have been in
existence for long periods of time. The accounting for these plans
is anything but straightforward and easy to apply.
The disclosures related to these pensions are far more extensive
than the numbers that show up on the face of the financial
statements. In fact, the bulk of the calculations required are for
the disclosures. The projected benefit obligation (PBO) and the
fair value of pension fund (FVPF) are numbers that are used
extensively in the calculations.
The PBO and FVPF are offset against each other and then reported
in net on the balance sheet as the pension-related asset/liability.
In addition, detailed disclosures are required for the accounts:
PBO, FVPF, and Accumulated Other Comprehensive Income (AOCI) which
includes deferred pension gains and losses and prior service
cost.
Pension expense is reported on the income statement and is the
sum of service cost and interest cost less the expected return on
the pension fund. In addition, pension expense can be affected by
the actual return on the pension, amortization of prior service
cost and deferred gain or loss.
Other benefits are provided to retirees besides pensions. The
accounting for them is similar to pensions, but there are some
differences.
Learning Objectives
Refer to the Review of Learning Objectives at the end of the
chapter. It is crucial that this section of the chapter is second
nature to you before you attempt the homework, a quiz, or exam.
This important piece of the chapter serves as your CliffsNotes or
“cheat sheet” to the basic concepts and principles that must be
mastered.
If after reading this section of the chapter you still don’t
feel comfortable with all of the Learning Objectives covered, you
will need to spend additional time and effort reviewing those
concepts that you are struggling with.
The following “Tips, Hints, and Things to Remember” are
organized according to the Learning Objectives (LOs) in the chapter
and should be gone over after reading each of the LOs in the
textbook.
Tips, Hints, and Things to Remember
LO1 – Account for payroll and payroll taxes, and understand the
criteria for recognizing a liability associated with compensated
absences.
How? The accounting for payroll taxes is fundamentally the same
as the accounting for salaries you have previously encountered. The
difference, here, is that more items are added to the journal
entry. Instead of the simple entry of debiting Salaries Expense and
crediting Cash or Salaries Payable, additional credits are added to
the entry for the various state, local, and federal taxes.
In addition, two entries are generally needed. One is for the
employee’s portion and includes not only wages, but also the
withholding on the employee’s wages that the employer is going to
remit to the government(s) on the employee’s behalf. The other
entry is for the employer’s portion of the obligations, usually
separately labeled as Payroll Tax Expense instead of Salary
Expense, and includes employer taxes like FICA, FUTA, and SUTA.
How? Vacation time is accounted for the same as salaries—on an
accrual basis. If vacation is earned, but not yet paid out, the
expense for it should still be accrued with a debit to Salary
Expense or Wages Expense and a credit to Vacation Wages Payable.
The salary used for the calculation of the accrual is the wage rate
in place when earned. If the vacation time is paid out when the
employee is making a higher wage, then the higher wage is paid out,
and the difference between the payout and the reversal of the
payable becomes an additional wages expense at the time of
payment.
LO2 – Compute performance bonuses, and recognize the issues
associated with postemployment benefits.
How? The variety of bonuses that can possibly be earned and paid
make it impossible to state that one simple formula is all you need
to know. Performance bonuses can, literally, be based on almost
anything. The key thing to keep in mind is that bonuses need to be
accrued when earned—not necessarily when paid. The debit is to some
sort of operating expense and the credit is to Bonus Payable or
Cash.
LO3 – Understand the nature and characteristics of employer
pension plans, including the details of defined benefit plans.
How? It is important to be able to distinguish between all of
the components of pensions and what the components are made up of.
For this learning objective, the key ones to get down are the
projected benefit obligation (PBO) and the fair value of the
pension fund (FVPF).
The formulas for the PBO and FVPF are important to know. Rather
than memorize them, try to think through them. They do make sense.
For the PBO, the calculation is as follows:
Beginning PBO balance
+ Current year costs for interest and service
–Retirement benefits paid
± Any changes in actuarial assumptions
= Ending PBO
For the FVPF, the calculation is as follows:
Beginning FVPF balance
+ Employer contributions
–Retirement benefits paid
± Actual return on pension fund
= Ending FVPF
In addition, it is important that you understand how to
calculate net pension expense shown on the income statement. Net
pension expense is interest cost plus service cost less expected
return on the pension fund.
LO4 – Use the components of the pension-related asset/liability
and changes in the components to compute the periodic expense
associated with pensions and to compute the impact on other
comprehensive income.
How? The key to your putting this chapter together is your
understanding of Exhibit 17-10. There are several items in this
exhibit that should be noted. The first is the amount of
pension-related asset/liability determined by simply taking the
difference between the PBO and FVPF. In Thornton’s case for 2015,
the pension-related liability is$405,342 ($2,003,692 –
$1,598,350).
Next, notice that each amount, other than beginning and ending
balances, show up in at least two columns. Completing a pension
work sheet is not a bad idea as you are working through a problem
for this reason. If you only list an item once, you know you have
forgotten it somewhere. In other words, creating a pension work
sheet may help you complete your work and make sure that you
haven’t forgotten anything. In addition, a pension work sheet will
help you accurately prepare the associated journal entries.
Finally, this exhibit shows every component you are likely to
encounter (in an academic setting or on the CPA Exam, anyway) as
part of the pension expense (service cost, interest cost, actual
return, benefits paid, and amortization). Actual return will
usually be a reduction in the pension expense. Amortization can
occasionally be a reduction in the pension expense. All of the
other items will increase pension expense for a given period.
LO5 – Prepare required disclosures associated with pensions, and
understand the accounting treatment for pension settlements and
curtailments.
Why? Similar to the discussions on disclosures for leases we had
in Chapter 15, disclosures for pensions provide the details that
most users of the financial statements really need. The accounts
that show up on the face of the financial statements related to
pensions tell the user very little. Look to the disclosure notes
for the FVPF and the PBO. These two numbers are usually more
important than anything involving pensions on the financial
statements. It is in the disclosures that one can find all of the
components that go into the summary numbers that make up pension
expense. The notes also inform users about the accumulated benefit
obligation (ABO), components of pension expense, and any effects on
other comprehensive income. Any assumptions that were used to
determine these items must also be disclosed.
LO6 – Explain the differences in accounting for pensions and
postretirement benefits other than pensions.
How? Pension accounting and other postretirement benefit
accounting are very similar. The three main differences are:
1. Other postretirement benefits are not usually funded.
2. Salary level isn’t the factor for “service cost.”
3. There is no minimum liability recognition (similar to the
international pension standards).
The following sections, featuring various multiple choice
questions, matching exercises, and problems, along with solutions
and approaches to arriving at the solutions, is intended to develop
your problem-solving and critical-thinking abilities. While
learning through trial and error can be effective for improving
your quiz and exam scores, and it can be a more interesting way to
study than merely re-reading a chapter, that is only a secondary
objective in presenting this information in this format.
The main goal of the following sections is to get you thinking,
“How can I best approach this problem to arrive at the correct
solution—even if I don’t know enough at this point to easily arrive
at the proper results?” There is not one simple approach that can
be applied to all questions to arrive at the right answer. Think of
the following approaches as possibilities, as tools that you can
place in your problem-solving toolkit—a toolkit that should be
consistently added to. Some of the tools have yet to even be
created or thought of. Through practice, creative thinking, and an
ever-expanding knowledge base, you will be the creator of the
additional tools.
Multiple Choice
MC17-1 (LO1) Which of the following accounting principles best
describes the rationale for reporting a liability for earned but
unused compensated absences?
a.
historical cost
b.
matching
c.
materiality
d.
comparability
MC17-2 (LO1) Which of the following taxes is NOT included in the
payroll tax expense of the employer?
a.
state unemployment taxes
b.
federal unemployment taxes
c.
FICA taxes
d.
federal income taxes
MC17-3 (LO2) Peach, Inc., has an incentive compensation plan
under which the sales manager receives a bonus equal to 10 percent
of the company’s income after deductions for the bonus and income
taxes. Income before the bonus and income taxes is $400,000. The
effective income tax rate is 30 percent. How much is the bonus
(rounded to the nearest dollar)?
a.
$40,000
b.
$30,108
c.
$28,000
d.
$26,168
MC17-4 (LO3) Which of the following statements characterizes
defined benefit plans?
a.
Retirement benefits are based on the plan’s benefit formula.
b.
They are comparatively simple in construction and raise few
accounting issues for employers.
c.
Retirement benefits depend on how well pension fund assets have
been managed.
d.
All of the above.
MC17-5 (LO3) The vested benefits of an employee in a pension
plan represent benefits
a.
to be paid to the retired employee in the current year.
b.
to be paid to the retired employee in subsequent years.
c.
to be paid from funds currently in the hands of an independent
trustee.
d.
that are not contingent on the employee's continuing in the
service of the employer.
MC17-6 (LO3) The following information relates to the defined
benefit pension plan of the Baying Company for the year ending
December 31, 2013:
Projected benefit obligation, January 1
$4,600,000
Projected benefit obligation, December 31
4,729,000
Fair value of pension fund, January 1
5,035,000
Fair value of pension fund, December 31
5,565,000
Expected return on plan assets
450,000
Amortization of deferred gain
32,500
Employer contributions
425,000
Benefits paid to retirees
390,000
Settlement interest rate
11%
The actual return on the pension fund for the year is
a.
$105,000.
b.
$495,000.
c.
$503,500.
d.
$530,000.
MC17-7 (LO4) The following information relates to Blazing Gold,
Inc., at December 31, 2013:
Fair value of pension fund
$1,520,000
Accumulated benefit obligation
1,960,000
Projected benefit obligation
2,040,000
The pension-related liability shown on the balance sheet at
December 31, 2013, for Blazing Gold, Inc., is
a.
$0.
b.
$440,000.
c.
$464,000.
d.
$520,000.
MC17-8 (LO4) On January 1, 2013, Cathode Corporation adopted a
defined benefit pension plan. The plan’s service cost of $300,000
was fully funded at the end of 2013. Prior service cost was funded
by a contribution of $120,000 in 2013. Amortization of prior
service cost was $48,000 for 2013. What is the amount of Cathode’s
prepaid pension cost at December 31, 2013?
a.
$0
b.
$72,000
c.
$120,000
d.
$168,000
MC17-9 (LO5) Which of the following is NOT a required disclosure
note for pensions?
a.
an estimate of the amount of cash to be paid in benefits (from
the pension fund assets) and the amount of cash to be contributed
by the company to the pension fund for the next five years
b.
the accumulated benefit obligation
c.
a reconciliation between the beginning and ending balances for
the projected benefit obligation and fair value of the pension
fund
d.
the vested benefit obligation
Matching
Matching 17-1 (LO1, LO2, LO3) Listed below are the terms and
associated definitions from the chapter for LO1 through LO3. Match
the correct definition letter with each term number.
___ 1.compensated absences
a.pension plans that specify the employer’s contributions based
on a formula that includes such factors as age, length of service,
employer’s profits, and compensation levels; the pension expense is
the amount funded each year
b.pension plans that define the benefits that employees will
receive at retirement; in these plans, it is necessary to determine
what the contribution should be to meet the future benefit
requirements
c.an agreement, usually written, that provides for benefits to
employees upon retirement from active employment; usually includes
provisions as to how the benefits are to be funded, who receives
benefits, the amount of benefits to be paid, and restrictions on
investments of pension plan assets
d.plans in which the employer bears the total cost of the
plan
e.a pension plan in which employees make contributions to the
plan and thus bear part of the cost
f.pension plans established for an individual employer; FASB ASC
Topic 715 primarily refers to this type of plan
g.payments by employers for vacation, holiday, illness, or other
personal activities
h.includes health insurance, life insurance, and disability
payments; current standards require these items to be accrued in a
manner similar to pension costs
___ 2.pension plan
___ 3.post-retirement benefits other than pensions
___ 4.single-employer pension plans
___ 5.noncontributory pension plans
___ 6.contributory pension plan
___ 7.defined contribution pension plans
___ 8.defined benefit pension plans
Matching 17-2 (LO3) Listed below are the terms and associated
definitions from the chapter for LO3. Match the correct definition
letter with each term number.
___ 1.pension fund
a.a component of net periodic pension expense representing the
actuarial present value of benefits accruing to employees for
services rendered during that period
b.amounts set aside to meet the employer’s future pension
obligation
c.the actuarial present value of pension benefits based on the
plan formula for employee service earned to date using the existing
salary structure; used to compute the minimum liability
d.the present value of pension obligations determined by using
stated actuarial assumptions and estimates
e.the actuarial present value of pension benefits using the
benefits/years of service approach that requires assumptions about
future compensation levels, such as increases over time by
interest, amendments to plan, additional service years, and changes
in actuarial assumptions
f.the amount recognized in an employer’s financial statements as
an expense of a pension plan for a period; components are service
cost, interest cost, actual return on plan assets, pension gain or
loss, amortization of unrecognized prior service cost, and
amortization of deferred gain or loss in excess of the corridor
amount
g.the amount of pension benefits an employee will retain if
employment with the employer is terminated
___ 2.vested benefits
___ 3.actuarial present value
___ 4.net periodic pension expense
___ 5.accumulated benefit obligation (ABO)
___ 6.projected benefit obligation (PBO)
___ 7.service cost
Matching 17-3 (LO3, LO4) Listed below are the terms and
associated definitions from the chapter for LO3 and LO4. Match the
correct definition letter with each term number.
___ 1.fair value of the pension fund
a.a component of net periodic pension expense measured by the
difference between the fair value of pension plan assets at the end
of the period and the fair value at the beginning of the period,
adjusted for contributions and payments of benefits during the
period
b.the pension fund’s market value at a given measurement date
that increases each year by employer contributions to the fund and
decreases by the retirement benefits paid; also changes by the
amount of earnings on the pension fund, including changes in its
market value
c.an amount calculated as a basis for determining the extent of
delayed recognition of the effects of changes in the fair value of
pension plan assets; determined based on the pension plan’s
expected long-term rate of return and market-related value
d.the present value of the increased benefits granted by a
pension plan’s amendment (or initial adoption of a plan);
recognized as a component of net periodic pension expense through
amortization over the future service life of the covered
employees
e.estimated number of years an employee will work before
receiving pension benefits; can be estimated as the average
computed life based on the total expected future years of service
divided by the number of employees; may be computed by the formula
[N(N + 1)/2] × D, where N equals the number of years over which
service is to be performed and D is the decrease in number of
employees through retirement or termination of services per
year
___ 2.prior service cost
___ 3.actual return on the pension fund
___ 4.expected service period
___ 5.expected return on the pension fund
Matching 17-4 (LO4, LO5, LO6) Listed below are the terms and
associated definitions from the chapter for LO4 through LO6. Match
the correct definition letter with each term number.
___ 1.corridor amount
a.an event that significantly reduces the expected number of
years of future services of present employees or eliminates for a
significant number of employees the accrual of defined benefits for
their future services
b.value of pension plan assets used in computing the expected
return; either of the following can be used: (1) the fair market
value of pension plan assets as of the beginning of the year or (2)
a weighted-average value based on the market value of plan assets
over a preceding period not exceeding five years
c.the date at which an employee attains full eligibility for the
benefits that employee is expected to earn under the terms of a
postretirement benefit plan
d.an irrevocable action taken by an employer that relieves the
employer of primary responsibility for all or part of the pension
obligation; examples include purchasing from an insurance company
an annuity that would cover employees’ vested benefits or a
lump-sum payment to employees in exchange for their rights to
receive specified pension benefits
e.an amount established as a minimum before amortization of
pension gains and losses is required; only amortization of
unrecognized pension gains and losses that exceed 10% of the
greater of the projected benefit obligation or the market-related
asset value as of the beginning of the period is included in the
net periodic pension expense
___ 2.settlement of a pension plan
___ 3.curtailment of a pension plan
___ 4.full eligibility date
___ 5.market-related value of the pension fund
Problems
Problem 17-1 (LO1) On June 30, 2013, payroll data from the
records of Reverie Enterprises showed:
Payroll:
Factory wages
$125,000
Office salaries
82,500
Sales salaries
98,000
Payroll deductions:
Income tax withholding
$47,800
FICA tax (7.65%)
?
Wages and salaries not subject to FICA tax:
Factory wages
$28,000
Office salaries
40,000
Sales salaries
45,000
Wages and salaries not subject to federal and state unemployment
taxes:
Factory wages
$60,000
Office salaries
80,000
Sales salaries
72,000
Provide the journal entries necessary to:
1. Record the payment of the payroll on June 30, 2013.
2. Record the employer's payroll tax liabilities. (The federal
unemployment tax rate is 0.8 percent; the state unemployment tax
rate is 5.4 percent.)
Round all numbers to the nearest dollar.
Problem 17-2 (LO3) The following data relate to the defined
benefit pension plan of the Cigaro Corporation during 2013:
Service cost
$4,200
Actual return on the pension fund
$625
Benefits paid to Retirees
$250
Contribution to the pension fund
$2,625
Discount rate for PBO
9%
Expected return on pension fund
10%
In addition, at the beginning of the year, Cigaro Corporation
had a projected benefit obligation (PBO) of $25,000 and a pension
fund with a fair value of $23,000. There were no prior service
cost, nor were the deferred pension gains or losses.
1. Determine the pension-related amount that should be reported
on the company’s balance sheet on January 1, 2013.
2. Determine the pension benefit obligation as of December 31,
2013.
3. Compute the fair value of the pension fund as of December 31,
2013.
4. Compute pension expense for the year.
5. Prepare the summary journal entries relating to the pension
plan for 2013.
Problem 17-3 (LO4, LO5) The following information relates to the
defined benefit pension plan of Tempesta Company:
Projected benefit obligation, January 1, 2013
$280,000
Projected benefit obligation, December 31, 2013
307,500
Accumulated benefit obligation, January 1, 2013
240,000
Accumulated benefit obligation, December 31, 2013
256,000
Benefits paid to retirees during 2013
22,000
Contributions by employer during 2013
37,500
Settlement interest rate
10%
1. Compute the amount of service cost for 2013.
2. Prepare the reconciliation between the beginning and ending
balances for the projected benefit obligation disclosure as
required by GAAP.
Solutions, Approaches, and Explanations
MC17-1
Answer: b
Approach and explanation: Accrual accounting is all about the
matching principle. Costs should be recognized against the revenues
they help produce—regardless of when the cash was paid for the
costs or when the cash is received for the revenues. It is when
salary, vacation time, bonuses, pensions, etc., are earned that the
expense should be recognized—not when they are paid in the
following year or years later. The expenses are matched with the
revenues they help generate (through the employee’s services). When
an employee takes the vacation later, they are not earning revenue
for the company in that later period by taking the vacation.
MC17-2
Answer: d
Approach and explanation: Federal income taxes, whether they be
those withheld from the employee’s paycheck or those paid by a
corporation on their earnings, are not part of payroll tax expense.
The federal income taxes withheld from employee paychecks serve to
reduce the amount of cash the employer pays the employee. They are
subsequently remitted to the federal government by the employer.
They remain an expense of the employee—not the employer.
State unemployment taxes (SUTA) can be on both the employee and
the employer, although they are usually on just the employer. In
either case, the employer will be paying for at least part, if not
all, of them and, hence, record payroll tax expense. FICA is split
between the employee and employer. Federal unemployment taxes
(FUTA) are paid for by just the employer.
MC17-3
Answer: d
Approach and explanation: Remember when you were sitting in
algebra class wondering when you would ever use it? Well, this is
just such an opportunity.
In a multiple-choice situation, like this, you can always plug
in the choices to find out which one fits. If the question was open
ended, you wouldn’t have that luxury. The
try-and-plug-all-four-choices method can be slower though.
Therefore, you should probably always start with an algebraic
equation. In this case it is:
B = 0.10 × (I – B – T)
where
B = Bonus
I = Income before the bonus and taxes
T = Taxes
Substituting what was given in the problem for the letters
results in:
B = 0.10 × {$400,000 – B – [($400,000 – B) × 0.30]}
B = $40,000 – 0.10B – $12,000 + 0.03B
1.07B = $28,000
B = $26,168
If algebra isn’t your strong point, and you opt for the
trial-and-error method, how can you possibly cut down the number of
trials you go through? Start with a middle choice and then, based
on your result, you can eliminate the choices above or below it.
Using that method, let’s start with choice c.
Income before the bonus and taxes
$400,000
Choice c bonus amount
28,000
Income before taxes
$372,000
Income taxes @ 30 percent
111,600
Net income
$260,400
Does net income equal 10 times the bonus? No, the bonus is too
high [at 11 percent of net income ($28,000/$260,400)]. Therefore,
choice c and any choice that is higher than choice c cannot be
correct. That leaves only choice d. Try it, if you have time, just
to check and make sure you are correct.
Income before the bonus and taxes
$400,000
Choice d bonus amount
26,168
Income before taxes
$373,832
Income taxes @ 30 percent
112,150
Net income
$261,682
Choice d checks out as the bonus is 10 percent of net income
($26,168/$261,682). It is a good idea to check yourself by doing a
partial income statement, as done above, if the question was open
ended as well.
MC17-4
Answer: a
Approach and explanation: There are two things to watch out for
on this question. The first is the word “benefit.” Circle,
underline, or highlight it so that you don’t forget that you are
dealing with defined benefit plans and not defined contribution
plans when looking at the choices. You may also want to write “NOT
contribution” in the margin for extra emphasis.
The next thing to watch out for is choice d. When seeing the
“all of the above” option, many students let their guard down a
bit. They tend to skim over the choices—especially if the first one
seems correct—to just get a feel for whether they all sound
correct, and if they do, then they opt for choice d.
Before reading any of the choices, you should clarify your
objective in your head. You are looking for sentences that describe
defined benefit plans—not defined contribution plans. Therefore, as
you read each choice you should indicate next to them which kind of
plan they describe with a B for benefit or a C for contribution.
This will help you to not hastily choose choice d, whether or not
it is correct.
Choice a describes defined benefit plans so put a B next to
choice a. Choice b describes defined contribution plans so put a C
next to choice b. Choice c also describes defined contribution
plans so it earns another C. Since you have two Cs and only one B,
you can cross off choice d. If you ended up with two Bs and only
one C, then you’d need to more closely exam the choices to see
which one you misclassified.
Here is a brief summary of the characteristics of defined
benefit plans:
· They are based on the plan’s benefit formula.
· They are more difficult to set up, manage, and account
for.
· They have fixed retirement for employees, so the employer
bears the risk if the fund assets’ investments don’t perform
well.
· They are usually funded entirely by the employer.
· Vesting is a factor.
MC17-5Answer: d
Approach and explanation: For retired employees who were vested,
choices a and b put together are correct. Choice c could be correct
but need not be, nor is it really a definition of vested benefits.
Choice d is the only true definition of vesting among the
choices.
MC17-6
Answer: bApproach and explanation: The first question to ask
yourself is, “What goes into the fair value of the pension fund?”
Remember from the How? associated with LO 3 that they are the items
that make sense. The value of the pension fund will go up by the
actual return on the pension fund, of course, but what are the
other factors?
The PBO has no impact on the fair value of pension fund assets,
so you can cross off the first two items. An expected return has no
effect, nor does amortization, so you can cross them both off. The
settlement interest rate is the discount rate used for computing
the interest cost on the PBO. Since it has nothing to do with the
fair value of the pension fund assets, it, too, can be
eliminated.
We are left with the change in the fair value of the pension
fund, employer contributions, retirement benefits paid, and the
actual return on pension fund. We could set them up as a T account
as follows:
FVPF
5,035,000
425,000
390,000
?
5,565,000
The only number that will get the ending fair value to
$5,565,000 is $495,000 ($5,565,000 – $425,000 + $390,000 –
$5,035,000).
MC17-7
Answer: d
Approach and explanation: Recall that pension-related liability
is the difference between the PBO and the FVPF+. In this case, that
amounts to $520,000 ($2,040,000 – $1,520,000).
MC17-8
Answer: b
Approach and explanation: If the service cost is fully funded,
then there is no asset or liability in conjunction with it. Hence,
the $300,000 amount can be ignored for the purposes of calculating
the prepaid pension cost at the end of the first year.
If the prior service cost is funded by an amount in excess of
the current year’s amortization in the first year of a plan, then
an asset will result by the amount of the difference ($120,000 –
$48,000).
The journal entry for the year would look like this:
Prepaid Pension Cost
72,000
Pension Expense
348,000
Cash
420,000
MC17-9
Answer: dApproach and explanation: Choice a is a disclosure
requirement. Companies have to state an estimate for the amount of
cash being paid into the fund and being paid as benefits for the
next five years
Choice c was the disclosure mentioned in LO5 as being probably
the first thing a user of the financial statements would want to
look at with respect to pensions—even before looking at the amount
of pension expense on the income statement or the prepaid/accrued
pension cost on the balance sheet. After all, it is the difference
between the PBO and the FVPF that determines the funding status of
a pension fund.
The vested benefit obligation (VBO) is a real number that can be
calculated, but it isn’t a required disclosure like the ABO. The
VBO is usually (significantly) less than the ABO, and the ABO is
usually (significantly) less than the PBO. The VBO would never be
more than the ABO or PBO. Likewise, the ABO would never be more
than the PBO.
Matching 17-1
1. g
2. c
3. h
4. f
5. d
6. e
7. a
8. b
Besides Chapter 1, this is probably the most difficult chapter
when it comes to terminology. Spend extra time understanding the
words that are new to you in this chapter or you will have a
difficult time mastering the material.
Matching 17-2
1. b
2. g
3. d
4. f
5. c
6. e
7. a
Matching 17-3
1. b
2. d
3. a
4. e
5. c
Matching 17-4
1. e
2. d
3. a
4. c
5. b
Problem 17-1
1.
Factory Wages Expense
125,000
Office Salaries Expense
82,500
Sales Salaries Expense
98,000
Cash
242,974
Employees Income Tax Payable
47,800
FICA Taxes Payable
14,726
Computation of FICA Taxes Payable:
Factory wages ($125,000 – $28,000)
$ 97,000
Office salaries ($82,500 – $40,000)
42,500
Sales salaries ($98,000 – $45,000)
53,000
$192,500
× .0765
$ 14,726
2.
Factory Payroll Tax Expense
11,451
Office Payroll Tax Expense
3,406
Sales Payroll Tax Expense
5,666
FICA Taxes Payable
14,726
Federal Unemployment Tax Payable
748
State Unemployment Tax Payable
5,049
Computation of payroll tax expense by employee group:
Factory
Office
Sales
FICA Tax (7.5%):
($125,000 – $28,000) × 7.65%
$ 7,421
($82,500 – $40,000) × 7.65%
$3,251
($98,000 – $45,000) × 7.65%
$4,054*
Federal Unemployment Tax (0.8%):
($125,000 – $60,000) × 0.8%
520
($82,500 – $80,000) × 0.8%
20
($98,000 – $72,000) × 0.8%
208
State Unemployment Tax (5.4%):
($125,000 – $60,000) × 5.4%
3,510
($82,500 – $80,000) × 5.4%
135
($98,000 – $72,000) × 5.4%
1,404
$11,451
$3,406
$5,666
* Rounded down.
Problem 17-2
1.Projected benefit obligation
$(25,000)
Pension fund
23,000
Net pension-related liability
$(2,000)
2.Projected benefit obligation, January 1
$(25,000)
Service cost
(4,200)
Interest cost ($25,000 ( 0.09)
(2,250)
Benefits paid to retirees
250
Projected benefit obligation, December 31
$(31,200)
3.Fair value of pension fund, January 1
$23,000
Actual return on pension fund
625
Contribution to pension fund
2,625
Benefits paid to retirees
(250)
Fair value of pension fund, December 31
$26,000
4.Service cost
$4,200
Interest cost ($25,000 ( 0.09)
2,250
Expected return on pension fund ($23,000 ( 0.10)
(2,300)
Pension expense
$4,150
5. Pension Expense
4,150
Other Comprehensive Income
1,675
Pension-Related Asset/Liability
5,825
Service cost + Interest cost – Actual return on pension fund =
$4,200 + $2,250 – $625 = $5,825
Deferred loss = Actual return of $625 – Expected return of
$2,300 = $1,675
Pension-Related Asset/Liability
2,625
Cash
2,625
Problem 17-3
1.
Projected benefit obligation, December 31, 2013
$307,500
Projected benefit obligation, January 1, 2013
280,000
Increase in projected benefit obligation
$ 27,500
Interest cost
(28,000)
Benefits paid to retirees
22,000
Service cost—2013
$ 21,500
2.
Projected benefit obligation, January 1, 2013
$280,000
Service cost
21,500
Interest cost
28,000
Benefits paid to retirees
(22,000)
Projected benefit obligation, December 31, 2013
$307,500
Glossary
Note that Appendix C in the rear portion of the textbook
contains a comprehensive glossary for all of the terms used in the
textbook. That is the place to turn to if you need to look up a
word but don’t know which chapter(s) it appeared in. The glossary
below is identical with one major exception: It contains only those
terms used in Chapter 17. This abbreviated glossary can prove quite
useful when reviewing a chapter, when studying for a quiz for a
particular chapter, or when studying for an exam which covers only
a few chapters including this one. Use it in those instances
instead of wading through the 19 pages of comprehensive glossary in
the textbook trying to pick out just those words that were used in
this chapter.
accumulated benefit obligation (ABO) The actuarial present value
of pension benefits based on the plan formula for employee service
earned to date using the existing salary structure; used to compute
the minimum liability.
actual return on the pension fund A component of net periodic
pension expense measured by the difference between the fair value
of pension plan assets at the end of the period and the fair value
at the beginning of the period, adjusted for contributions and
payments of benefits during the period.
actuarial present value The present value of pension obligations
determined by using stated actuarial assumptions and estimates.
compensated absences Payments by employers for vacation,
holiday, illness, or other personal activities.
contributory pension plan A pension plan in which employees make
contributions to the plan and thus bear part of the cost.
corridor amount An amount established as a minimum before
amortization of pension gains and losses is required. Only
amortization of unrecognized pension gains and losses that exceed
10% of the greater of the projected benefit obligation or the
market-related asset value as of the beginning of the period is
included in the net periodic pension expense. Any systematic method
of amortization that exceeds the minimum may be used as long as it
is consistently applied to both gains and losses and it is
disclosed in the statements.
curtailment of a pension plan An event that significantly
reduces the expected number of years of future services of present
employees or eliminates for a significant number of employees the
accrual of defined benefits for their future services.
deferred net pension gain or loss The deferred gain or loss
arising from the adjustment to the projected benefit
obligation.
deferred pension gain or loss The differences between expected
results and actual experience that were used in determining net
periodic pension expense for previous periods.
defined benefit pension plans Pension plans that define the
benefits that employees will receive at retirement. In these plans,
it is necessary to determine what the contribution should be to
meet the future benefit requirements. FASB ASC Topic 715 deals
primarily with this type of pension plan.
defined contribution pension plans Pension plans that specify
the employer’s contributions based on a formula that includes such
factors as age, length of service, employer’s profits, and
compensation levels. FASB ASC Topic 715 does not deal with these
types of plans. The pension expense is the amount funded each
year.
expected return on the pension fund An amount calculated as a
basis for determining the extent of delayed recognition of the
effects of changes in the fair value of pension plan assets. The
expected return on pension plan assets is determined based on the
pension plan’s expected long-term rate of return and market-related
value.
expected service period Estimated number of years an employee
will work before receiving pension benefits. Can be estimated as
the average computed life based on the total expected future years
of service divided by the number of employees. The expected future
years of service may be computed by the formula [N(N + 1)/2] × D,
where N equals the number of years over which service is to be
performed and D is the decrease in number of employees through
retirement or termination of services per year.
fair value of the pension fund Value based on the pension fund’s
market value at a given measurement date that increases each year
by employer contributions to the fund and decreases by the
retirement benefits paid; also changes by the amount of earnings on
the pension fund, including changes in its market value.
full eligibility date The date at which an employee attains full
eligibility for the benefits that employee is expected to earn
under the terms of a postretirement benefit plan.
market-related value of the pension fund Value of pension plan
assets used in computing the expected return. Either of the
following can be used as the market-related value: (1) the fair
market value of pension plan assets as of the beginning of the year
or (2) a weighted-average value based on the market value of plan
assets over a preceding period not exceeding five years.
net periodic pension expense The amount recognized in an
employer’s financial statements as an expense of a pension plan for
a period. Components of net periodic pension expense are service
cost, interest cost, actual return on plan assets, pension gain or
loss, amortization of unrecognized prior service cost, and
amortization of deferred gain or loss in excess of the corridor
amount.
noncontributory pension plans Plans in which the employer bears
the total cost of the plan.
obligation discount rate The 10% discount rate used in the
computation of the projected benefit obligation and viewed as the
implied interest rate on this debt.
pension fund Fund set aside to meet the employer’s future
pension obligation.
pension plan An agreement, usually written, that provides for
benefits to employees upon retirement from active employment. The
plan usually includes provisions as to how the benefits are to be
funded, who receives benefits, the amount of benefits to be paid,
and restrictions on investments of pension plan assets.
pension-related asset/liability An account used to reflect
changes in the net pension asset or liability.
post-retirement benefits other than pensions Benefits other than
pensions provided by an employer to former employees. Includes
health insurance, life insurance, and disability payments. Current
standards require these benefits to be accrued in a manner similar
to pension costs.
prior service cost The present value of the increased benefits
granted by a pension plan’s amendment (or initial adoption of a
plan). Recognized as a component of net periodic pension expense
through amortization over the future service life of the covered
employees.
projected benefit obligation (PBO) The actuarial present value
of pension benefits using the benefits/years of service approach
that requires assumptions about future compensation levels, such as
increases over time by interest, amendments to plan, additional
service years, and changes in actuarial assumptions.
service cost A component of net periodic pension expense
representing the actuarial present value of benefits accruing to
employees for services rendered during that period.
settlement of a pension plan An irrevocable action taken by an
employer that relieves the employer of primary responsibility for
all or part of the pension obligation. Examples include purchasing
from an insurance company an annuity that would cover employees’
vested benefits or a lump-sum payment to employees in exchange for
their rights to receive specified pension benefits.
single-employer pension plans Pension plans established for a
single employer. FASB ASC Topic 715 primarily refers to this type
of plan.
vested benefits The amount of pension benefits an employee will
retain if employment with the employer is terminated.